SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-68080; File No. S7-08-11]

RIN 3235 AL13

Clearing Agency Standards

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

SUMMARY: The Securities and Exchange Commission ("SEC" or "Commission") is adopting a new rule in accordance with the Securities Exchange Act of 1934 ("Exchange Act"), and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 ("Dodd-Frank Act"). The new rule establishes minimum requirements regarding how registered clearing agencies must maintain effective risk management procedures and controls as well as meet the statutory requirements under the Exchange Act on an ongoing basis.

Congress directed the Commission to facilitate the establishment of a national system for the prompt and accurate clearance and settlement of securities transactions when it added Section 17A to the Exchange Act as part of the Securities Acts Amendments of 1975.1The Commission's ability to achieve this goal and its supervision of securities clearance and settlement systems is based upon the regulation of registered clearing agencies. Over the years, clearing agencies registered with the Commission have become an essential part of the infrastructure of the U.S. securities markets. Clearing agencies help reduce the costs of securities trading and are required to be carefully structured to manage and reduce counterparty risk.

1See15 U.S.C. 78q-1 and S. Rep. No. 94-75, at 4 (1975) (the Senate Committee on Banking, Housing and Urban Affairs urging that “[t]he Committee believes the banking and security industries must move quickly toward the establishment of a fully integrated national system for the prompt and accurate processing and settlement of securities transactions”).

The Commission used this experience with regulating clearing agencies to help address developments recently in the over-the-counter (“OTC”) derivatives markets. In December 2008, the Commission acted to facilitate the central clearing of credit default swaps (hereinafter referred to as “credit default swaps” or “CDS”), the largest category of OTC security-based swaps, by permitting certain entities that performed central counterparty (“CCP”) services to clear and settle credit default swaps on a temporary, conditional basis.2Consequently, some creditdefault swaps transactions were centrally cleared prior to the enactment of the Dodd-Frank Act.

Section 17A of the Exchange Act3and Rule 17Ab2-14require entities to register with the Commission prior to performing the functions of a clearing agency. Under the statute, the Commission is not permitted to grant registration unless it determines that the rules and operations of the clearing agency meet the standards set forth in Section 17A.5If the Commission registers a clearing agency, the Commission oversees the clearing agency to facilitate compliance with the Exchange Act using various tools that include, among other things, the rule filing process for self-regulatory organizations (“SROs”) and on-site examinations by Commission staff. Section 17A(d) also gives the Commission authority to adopt rules for clearing agencies as necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Exchange Act and prohibits a registered clearing agency from engaging in any activity in contravention of these rules and regulations.6Pursuant to Section 21(a) of the Exchange Act, the Commission can invoke its enforcement powers to initiate and conduct investigations to determine violations of the federal securities laws, including those specifically applicable to clearing agencies.7In so doing, the Commission may institute civil actions seeking injunctive and other equitable remedies and/or administrative proceedings to, among other things, suspend or revoke registration, impose limitations upon a clearing agency's activities, functions, or operations, or impose other sanctions.8

5Specifically, Sections 17A(b)(3)(A)-(I) identify determinations that the Commission must make about the rules and structure of a clearing agency prior to granting registration.See15 U.S.C. 78q-1(b)(3)(A)-(I). The staff of the Commission provided guidance on meeting the requirements of Section 17A in its Announcement of Standards for the Registration of Clearing Agencies.SeeExchange Act Release No. 16900 (June 17, 1980), 45 FR 41920 (June 23, 1980).

6See15 U.S.C. 78q-1(d).

7See15 U.S.C. 78u.

8See id.;see also15 U.S.C. 78s(h).

3. The Dodd-Frank Act

On July 21, 2010, President Barack Obama signed the Dodd-Frank Act into law.9The Dodd-Frank Act was enacted to, among other things, promote the financial stability of the United States by improving accountability and transparency in the financial system.10

Title VII of the Dodd-Frank Act (“Title VII”) provides the Commission and the Commodity Futures Trading Commission (“CFTC”) with enhanced authority to regulate certain OTC derivatives in response to the recent financial crisis.11The Dodd-Frank Act is intended to bolster the existing regulatory structure and provide regulatory tools to oversee the OTC derivatives market, which has grown exponentially in recent years and is capable of affecting significant sectors of the U.S. economy. Title VII provides that the CFTC will regulate “swaps,” the Commission will regulate “security-based swaps,” and the CFTC and the Commission will jointly regulate “mixed swaps.”12

Title VII was designed to provide greater certainty that, wherever possible and appropriate, swap and security-based swap contracts formerly traded exclusively in the OTC market are centrally cleared.13The swap and security-based swap markets traditionally have been characterized by privately negotiated transactions entered into by two counterparties, in which each assumes the credit risk of the other counterparty.14Clearing of swaps and security-based swaps was at the heart of Congressional reform of the derivatives markets in Title VII.15Clearing agencies are broadly defined under the Exchange Act and undertake a variety of functions.16One such function is to act as a CCP, which is an entity that interposes itself between the counterparties to a trade.17For example, when a security-based swap contract between two counterparties that are members of a CCP is executed and submitted for clearing, it is typically replaced by two new contracts—separate contracts between the CCP and each of the two original counterparties. At that point, the original parties to the transaction are no longer counterparties to each other. Instead, each acquires the CCP as its counterparty, and the CCP assumes the counterparty credit risk of each of the original counterparties that are members of the CCP.18Structured and operated appropriately, CCPs may improve the management of counterparty risk and may provide additional benefits such as multilateral netting of trades.19The Dodd-Frank Actamended the Exchange Act to require, among other things, that transactions in security-based swaps must be cleared through a clearing agency if they are of a type that the Commission determines must be cleared, unless an exemption from mandatory clearing applies.20Title VII of the Dodd-Frank Act also added new provisions to the Exchange Act that require entities that act as a clearing agency with respect to security-based swaps (“security-based swap clearing agencies”) to register with the Commission21and require the Commission to adopt rules with respect to security-based swap clearing agencies.22Compliance with any such rules is a prerequisite to the registration of a clearing agency with the Commission and is also a condition to the maintenance of its continued registration.23Finally, Title VII provided that some of the entities that the Commission permitted to clear and settle credit default swaps on a temporary, conditional basis prior to the July 21, 2010, enactment of the Dodd-Frank Act were deemed to be registered clearing agencies (the “Deemed Registered Provision”).24

13See, e.g.,Report of the Senate Committee,supranote 11, at 34 (stating that “[s]ome parts of the OTC market may not be suitable for clearing and exchange trading due to individual business needs of certain users. Those users should retain the ability to engage in customized, uncleared contracts while bringing in as much of the OTC market under the centrally cleared and exchange-traded framework as possible.”).

16Section 3(a)(23)(A) of the Exchange Act defines the term “clearing agency” to mean any person who acts as an intermediary in making payments or deliveries or both in connection with transactions in securities or who provides facilities for the comparison of data regarding the terms of settlement of securities transactions to reduce the number of settlements of securities transactions or the allocation of securities settlement responsibilities. Such term also means any person, such as a securities depository, who (i) acts as a custodian of securities in connection with a system for the central handling of securities whereby all securities of a particular class or series of any issuer deposited within the system are treated as fungible and may be transferred, loaned or pledged by bookkeeping entry without physical delivery of securities certificates, or (ii) otherwise permits or facilitates the settlement of securities transactions or the hypothecation or lending of securities without physical delivery of securities certificates. 15 U.S.C. 78c(a)(23)(A).

17See id.An entity that acts as a CCP for securities transactions is a clearing agency as defined in the Exchange Act and is required to register with the Commission.

19See id.at 46;see alsoBank for International Settlements' Committee on Payment and Settlement Systems and Technical Committee of the International Organization of Securities Commissions,Guidance on the Application of the 2004 CPSS-IOSCO Recommendations for CentralCounterparties to OTC Derivatives CCPs: Consultative Report(May 2010),available athttp://www.bis.org/publ/cpss89.pdf.

2115 U.S.C. 78q-1(g) (adding subparagraph (g) to Section 17A of the Exchange Act). Pursuant to Section 774 of the Dodd-Frank Act, the requirement in Section 17A(g) of the Exchange Act for security-based swap clearing agencies to be registered with the Commission took effect on July 16, 2011.

2215 U.S.C. 78q-1(i) and (j). Public Law 111-203 sec. 763(b) (adding subparagraphs (i) and (j) to Section 17A of the Exchange Act).

23Under the Exchange Act, a clearing agency can be registered with the Commission only if the Commission makes a determination that the clearing agency satisfies the requirements set forth in paragraphs (A) through (I) of Section 17A(b)(3) of the Exchange Act. 15 U.S.C. 78q-1(b)(3).

24See15 U.S.C. 78q-1(l). The Deemed Registered Provision applies to certain depository institutions that cleared swaps as multilateral clearing organizations and certain derivatives clearing organizations (“DCOs”) that cleared swaps pursuant to an exemption from registration as a clearing agency. As a result, ICE Clear Credit LLC, ICE Clear Europe Limited and the Chicago Mercantile Exchange, Inc. were deemed registered clearing agencies with the Commission on July 16, 2011, solely for the purpose of clearing security-based swaps. Under this Deemed Registered Provision, an eligible clearing agency is deemed registered for the purpose of clearing security-based swaps and is therefore required to comply with all requirements of the Exchange Act, and the rules thereunder, applicable to registered clearing agencies, including, for example, the obligation to file proposed rule changes under Section 19(b) of the Exchange Act.

b. Title VIII of the Dodd-Frank Act

In addition to the provisions from Title VII that expand the Commission's authority under the Exchange Act to include activities related to security-based swaps, Title VIII of the Dodd-Frank Act, entitled the Payment, Clearing, and Settlement Supervision Act of 2010 (“Clearing Supervision Act”), establishes an enhanced supervisory and risk control system for systemically important clearing agencies and other financial market utilities (“FMUs”).25In part, the Clearing Supervision Act provides that the Commission, considering relevant international standards and existing prudential requirements, may prescribe regulations that contain risk management standards for the operations related to payment, clearing, and settlement activities (“PCS Activities”)26of a Designated Clearing Entity or the conduct of designated activities by a Financial Institution.27In prescribing such standards, the Commission must consult the Board of Governors of the Federal Reserve System (“Federal Reserve” or “the Board”) and the Financial Stability Oversight Council (“Council”). On July 11, 2011, the Council published a final rule concerning its authority to designate FMUs as systemically important,28and on July 18, 2012, the Council designated The Depository Trust Company (“DTC”), Fixed Income Clearing Corporation (“FICC”), National Securities Clearing Corporation (“NSCC”) and The Options Clearing Corporation (“OCC”) as systemically important.29

25See infranote 29. Under Section 803 of the Clearing Supervision Act, clearing agencies may be FMUs. Therefore, the Commission may be the Supervisory Agency of a clearing agency that is designated as systemically important (“Designated Clearing Entity”) by the Financial Stability Oversight Council (“Council”).See12 U.S.C. 5463. The definition of “FMU,” which is contained in Section 803(6) of the Clearing Supervision Act, contains a number of exclusions including, but not limited to, designated contract markets, registered futures associations, swap data repositories, swap execution facilities, national securities exchanges, national securities associations, alternative trading systems, security-based swap data repositories, security-based swap execution facilities, brokers, dealers, transfer agents, investment companies and futures commission merchants. 12 U.S.C. 5462(6)(B). The designation of systemic importance hinges on a determination by the Council that the failure of, or a disruption to, the functioning of the FMU could create, or increase, the risk of significant liquidity or credit problems spreading among financial institutions or markets and thereby threaten the stability of the financial system of the United States.See12 U.S.C. 5463(a)(2)(A)-(E). The designation of an FMU is significant, in part, because it will subject such designated entity to heightened oversight consistent with the terms of the Clearing Supervision Act. For example, the Clearing Supervision Act requires the Supervisory Agency to examine at least once annually any FMU that the Council has designated as systemically important. The Commission intends to conduct such annual statutory cycle examinations on the Commission's fiscal year basis. The Commission staff anticipates conducting the first annual statutory cycle examination of any designated FMU for which it is the Supervisory Agency in the annual cycle following such designation.

26Certain post-trade processing activities that are not captured by the Clearing Supervision Act may nevertheless be subject to regulation by the Commission under the Exchange Act.See infranote 100 and accompanying text.

27SeeSection 805(a)(2) of the Clearing Supervision Act. Those regulations may govern “(A) the operations related to payment, clearing, and settlement activities of such designated clearing entities; and (B) the conduct of designated activities by such financial institutions.” 12 U.S.C. 5464(a)(2). PCS Activities are defined in Section 803(7) of the Clearing Supervision Act. 12 U.S.C 5462(7).

The definition of “financial institution,” which is contained in Section 803(5) of the Clearing Supervision Act, outlines numerous exclusions but defines financial institution as a branch or agency of a foreign bank, an organization operating under Section 25 or 25A of the Federal Reserve Act, a credit union, a broker or dealer, an investment company, an insurance company, an investment adviser, a futures commission merchant, commodity trading advisor or commodity pool operator and any company engaged in activities that are financial in nature or incidental to a financial activity. 12 U.S.C. 5462(5)(A).

28See76 FR 44763 (July 27, 2011) (the Council also expects to address the designation of payment, clearing, or settlement activities as systemically important in a separate rulemaking).

29See12 U.S.C. 5321 (establishing the Council and designating its voting and nonvoting members);see also12 U.S.C. 5463 (designation of systemic importance). In accordance with Section 804 of the Clearing Supervision Act, the Council has the authority, on a non-delegable basis and by a vote of not fewer than two-thirds of the members then serving, including the affirmative vote of its chairperson, to designate those FMUs that the Council determines are, or are likely to become, systemically important. The Council may, using the same procedures, rescind such designation if it determines that the FMU no longer meets the standards for systemic importance. Before making either determination, the Council is required to consult with the Board and the relevant Supervisory Agency as determined in accordance with Section 803(8) of the Clearing Supervision Act. Section 804 also sets forth procedures that give entities 30 days advance notice and an opportunity for a hearing prior to being designated as systemically important.

B. International Considerations

Section 17A(i) of the Exchange Act provides that the Commission, in establishing clearing agency standards and in its oversight of clearing agencies, may conform such standards and such oversight to reflect evolving international standards.30Section 805(a) of the Clearing Supervision Act directs the Commission to take into consideration relevant international standards and existing prudential requirements for clearing agencies that are designated as FMUs.31The current international standards most relevant to risk management of clearing agenciesare the standards developed by the International Organization of Securities Commissions (“IOSCO”) and the Committee on Payment and Settlement Systems (“CPSS”) that are contained in the report entitledPrinciples for Financial Market Infrastructures(“FMI Report”).32The final FMI Report was published on April 16, 2012, and replaces CPSS and IOSCO's previous standards applicable to clearing agencies that were contained in the following reports:Recommendations for Securities Settlement Systems(2001) (“RSSS”) andRecommendations for Central Counterparties(2004) (“RCCP”) (collectively, “CPSS-IOSCO Recommendations”).33These international standards were formulated by securities regulators and central banks to promote sound risk-management practices and encourage the safe design and operation of entities that provide clearance and settlement services. The FMI Report harmonizes and, where appropriate, strengthens the previous international standards; it also incorporates additional guidance for OTC derivatives CCPs.34

33The complete RSSS and RCCP Reports are available on the Web site of the Bank for International Settlements athttp://www.iosco.org/library/pubdocs/pdf/IOSCOPD123.pdfandhttp://www.iosco.org/library/pubdocs/pdf/IOSCPD176.pdfrespectively.

The Board applies these standards in its supervisory process and expects systemically important systems, as determined by the Board and subject to its authority, to complete a self-assessment against the standards set forth in the policy.SeePolicy on Payment System Risk, 72 FR 2518 (Jan. 12, 2007).

34See FMI Report,supranote 32.

II. Overview of Proposal and General Comments Received on the Proposing Release and Commission ResponseA. Summary of the Clearing Agency Standards Proposing Release

On March 3, 2011, the Commission proposed for comment a series of rules related to standards for the operation and governance of clearing agencies (“Proposing Release”).35The Proposing Release contained the following proposals:

(5) Proposed Rule 17Ab2-1, which would amend an existing Commission rule concerning registration of clearing agencies to account for security-based swap clearing agencies and to make other technical changes;

(6) Proposed Rule 17Ad-25, which would require all clearing agencies to have procedures that identify and address conflicts of interest;

(7) Proposed Rule 17Ad-26, which would require clearing agencies to set standards for all members of their boards of directors or committees; and

(8) Proposed Rule 3Cj-1, which is modeled on Section 3C(j) of the Exchange Act and would require all clearing agencies to designate a chief compliance officer.

The Commission also noted in the Proposing Release that the definition of clearing agency under Section 3(a)(23)(A) of Exchange Act includes any person who:

• Acts as an intermediary in making payments or deliveries or both in connection with transactions in securities;

• Provides facilities for the comparison of data regarding the terms of settlement of securities transactions, to reduce the number of settlements of securities transactions, or for the allocation of securities settlement responsibilities;

• Acts as a custodian of securities in connection with a system for the central handling of securities whereby all securities of a particular class or series of any issuer deposited within the system are treated as fungible and may be transferred, loaned, or pledged by bookkeeping entry, without physical delivery of securities certificates (such as a securities depository); or

• Otherwise permits or facilitates the settlement of securities transactions or the hypothecation or lending of securities without physical delivery of securities certificates (such as a securities depository).36

3615 U.S.C. 78c(a)(23)(A).

Based on the Exchange Act definition, the Commission stated its preliminary view that certain post-trade processing services may fall within the clearing agency definition and asked for comments regarding the Commission's preliminary interpretation.

Since the publication of the Proposing Release, the Commission has received 25 comment letters on the Proposing Release from a broad range of market participants, and the Commission and staff also had discussions with representatives of clearing agencies, trade associations, public interest groups and other interested parties.37The Commission has taken into consideration international initiatives and consulted with other U.S. financial regulators as appropriate, including theCFTC and the Federal Reserve, to inform the Commission's final actions. Commenters generally supported the goals of the proposal. As further discussed below, however, several commenters recommended that the proposal be amended or clarified in certain respects.

After careful review and consideration of the comments, the Commission is today adopting Rule 17Ad-22, with certain modifications discussed below, to address comments received. As adopted, Rule 17Ad-22 is meant to establish minimum requirements for registered clearing agency risk management practices and operations with due consideration given to equivalent standards of other regulators in the United States38and to international standards, as discussed above in Section I.B. We expect to address separately the other proposed rules and matters contained in the Proposing Release as explained in more detail in Section II.B below.

B. General Comments Received on the Proposing Release and the Commission Response

The Proposing Release was published in theFederal Registeron March 16, 2011, and the comment period closed on April 29, 2011.39The Proposing Release contained proposed rules that cover various aspects of a clearing agency's operations and risk management that are listed in full in Section II.A. In addition to specific comments regarding the substance of the rules in the Proposing Release, a number of the comments the Commission received concern the larger framework for our rulemaking efforts involving clearing agencies and the manner in which the rules may be implemented. These comments focus on issues such as ensuring that: (1) Sufficient time be given to clearing agencies to implement all new standards appropriately; (2) the Commission's regulations relating to risk management standards in particular be given careful consideration and recognize the complexity of the issues involved; (3) the Commission's regulations are consistent with those of other U.S. regulatory agencies and CPSS and IOSCO initiatives; and (4) appropriate distinctions between clearing agencies that provide CCP and central securities depository (“CSD”) services from those that provide post-trade processing services are recognized in the Commission's regulations.

39See supranote 35.

Set forth below is a description of the comments received by the Commission that express concerns about the general approach to clearing agency reform reflected in the Proposing Release. The Commission has carefully considered these general comments that were provided concerning the larger framework for our rule making efforts involving clearing agencies.40To address the concerns they raise, we have determined to take the actions described below.

40See supranote 9, at Preamble.

1. Timing of Implementationa. Comments Received

Three commenters asked for the implementation of the proposed rules to be subject to appropriate phase-in periods.41One commenter suggested that the appropriate phases should be determined by the Commission in consultation with the affected clearing agencies.42Another commenter requested that if the rules are adopted as proposed then they should not become effective for at least two years.43Two commenters stated that they believe that implementing all of the proposed rules in the Proposing Release at the same time would require extensive new policies and procedures, drafting, proposing and approval of rules and rule changes, raising additional financial resources, hiring and training of personnel, operational changes and many other tasks that would require clearing agencies to simultaneously respond to separate requirements promulgated under the Dodd-Frank Act.44Accordingly, these commenters requested that the Commission provide adequate time to implement necessary changes and expressed that phase-in periods would be appropriate.

43SeeThe OCC Letter at 17 (adding that if the Commission adopts a financial resources standard in Rule 17Ad-22(b)(3) to require a security-based swaps clearing agency that performs CCP services to have enough financial resources to be able to withstand the default of its two largest participants in extreme but plausible market conditions then that requirement should be subject to delayed implementation of at least two years).

44See id.;The DTCC (April) Letter at 6.

One commenter asked the Commission to publish any modifications it may make to the proposed rules for an additional comment period.45Others stressed that if the Commission makes significant changes to its proposed rules, then the rules should be republished for further comment.46

45SeeThe DTCC (April) Letter at 2.

46SeeThe OCC Letter at 17.

One commenter stated that clearing agency rules such as those related to governance, conflicts of interest, registration, and financial resources should be adopted early in the implementation of rules for the security-based swap market.47The commenter also stated that barriers to effective “buy-side” participation in CCPs must be eliminated early in the phase-in process to enable “buy-side” participants to clear voluntarily at the same time as dealers.48

47SeeMFA (Kaswell/King) Letter at Annex A.

48See id.

b. Commission Response

In light of the request by commenters for a phased approach to implementation of the clearing agency standards set forth in the Proposing Release,49the Commission has decided to address the standards in stages.

49See supranotes 41-44 and accompanying text.

• In the first stage, the Commission is adopting only Rule 17Ad-22. The compliance date for Rule 17Ad-22 will be sixty days from publication in theFederal Register.

• The second planned stage in the implementation of standards for clearing agencies is the consideration by the Commission of rules that correspond to proposed Rules 17Aj-1; 17Ad-23; 17Ad-24; 17Ab2-1 and 3Cj-1 as well as the clearing agency governance and conflict of interest concerns that its previous proposal addressed through its proposal of Rule 17Ad-25, Rule 17Ad-26 and Regulation MC.50

• The third planned stage is for the Commission to consider rules tailored to clearing agencies that perform certain post-trade processing services. The Commission sought comment concerning these types of clearing agencies in the Proposing Release and preliminarily intends to propose rules addressed to them as described in more detail in Sections II.B.4 and III.A below. As appropriate, the Commission mayalso propose rules that will incorporate principles set forth in the FMI Report.

The Commission believes the phased approach to implementation provides clearing agencies with the benefit of additional time with respect to some of the requirements contemplated in the Proposing Release, while putting into place minimum standards for operational and risk management practices of registered clearing agencies. This approach will allow the Commission to consider further the comments received on the Proposing Release and evolution of clearance and settlement activity in light of the requirements of Title VII and Title VIII of the Dodd-Frank Act, including the implementation of the mandatory clearing requirements with respect to security-based swaps mandated by the Dodd-Frank Act. Because the Commission is adopting 17Ad-22 largely as proposed, the Commission is not republishing Rule 17Ad-22 for additional comments.

We believe that the implementation of these standards is an important first step in crafting regulatory changes contemplated by Title VII and Title VIII of the Dodd-Frank Act as intended by Congress. The adoption of Rule 17Ad-22 will also allow the Commission to coordinate its activities as the supervisory agency for clearing agencies designated as systemically important financial market utilities under Title VIII of the Dodd-Frank Act with the complementary responsibilities of the Federal Reserve.51In addition, the Commission believes that the adoption of standards for registered clearing agencies at this time will help facilitate the development of the security-based swap market. Rule 17Ad-22 establishes minimum standards for a wide range of issues, including governance, financial resources and membership. For example, Rules 17Ad-22(b)(5), (6) and (7) are designed to prohibit membership practices that may limit competition among market participants. In particular, Rule 17Ad-22(b)(6) is designed to facilitate correspondent clearing, which will allow buy-side participants to obtain access to CCP services without having to become direct members of a clearing agency.

51Section 805 of the Clearing Supervision Act provides that (i) the Commission may prescribe standards for designated clearing entities in consultation with the Council and the Board and (ii) the Board may determine that the Commission's existing prudential requirements with respect to designated clearing entities are insufficient to prevent or mitigate significant credit, liquidity, operational or other risks to the financial markets or the financial stability of the United States.

2. Special Attention to Risk Management Standardsa. Comments Received

Generally, commenters supported the requirements of proposed Rules 17Ad-22(b)(1)-(4) that would govern the risk management standards and practices of registered clearing agencies that perform CCP services or CCPs.52However, in several respects, commenters asked the Commission to pay special attention to the technical nature of CCP risk management practices that are addressed by these rules. The comments received by the Commission span a range of views on these matters. But thematically, many of them coalesce around a question of whether the Commission should prescribe detailed specifications within these rules to define compliance standards more clearly or take a less prescriptive approach that affords clearing agencies greater discretion to establish, implement, maintain and enforce policies and procedures based on the facts and circumstances of the individual clearing agency.

52SeediscussioninfraSection III.C.

For instance, proposed Rule 17Ad-22(b)(1) would require a CCP to establish, implement, maintain and enforce written policies and procedures reasonably designed to measure credit exposures to participants at least once a day and limit exposures to potential losses from defaults by its participants in normal market conditions so that the operations of the clearing agency would not be disrupted and non-defaulting participants would not be exposed to losses that they cannot anticipate or control. Of those commenters who asked the Commission to consider modifications to the proposed rule, two suggested that public disclosure requirements should accompany any choice made by a CCP to reduce margin requirements on the basis of an inverse or offsetting correlation between participants' positions.53Several others focused on what role the Commission should take in defining “normal market conditions” for purposes of the rule54as well as how frequently a CCP should be required to measure its credit exposures55and whether such measurements should be required to include the customers of participants.56

53SeeISDA Letter at 7; Better Markets Letter at 3-4.

54SeeThe OCC Letter at 7; Better Markets Letter at 3-4.

55SeeLCH Letter at 2; Better Markets Letter at 5.

56SeeLCH Letter at 2.

Proposed Rule 17Ad-22(b)(2) would require a CCP to establish, implement, maintain and enforce written policies and procedures reasonably designed to use margin requirements to limit its credit exposures to participants under normal market conditions and use risk-based models57to set margin requirements and review them at least monthly. One commenter argued that CCPs should be required to make their margin-setting methodology available to customers to help them understand the responsibilities that are commensurate with CCP participation.58Another commenter suggested clearing agencies should have discretion when complying with the rule to decide which aspects of a margin methodology are appropriate for monthly review.59Still other commenters concentrated on the extent to which the Commission should prescribe the parameters of a CCP's margin model, such as the confidence level, amount of data used to inform the standard of “normal market conditions,” and the use of factors such as liquidity and concentration.60

57The term “risk-based models” is meant to encompass any models, systems and associated parameters used by clearing agencies to mitigate risks.

With respect to proposed Rule 17Ad-22(b)(3), commenters asked the Commission to give further consideration to whether it is appropriate to create different financial resources standards for a security-based swap CCP. As proposed, the rule would require a CCP to establish, implement, maintain and enforce written policies and procedures reasonably designed to maintain sufficient financial resources to withstand, at a minimum, a default by the participant to which it has the largest exposure in extreme but plausible market conditions, provided that a security-based swap clearing agency would be required to maintain sufficient financial resources to withstand, at a minimum, a default by the two participants to which it has the largest exposures in extreme but plausible market conditions. One commenter argued that characteristics of the instruments traded in the security-based swap market support differentiating the requirements of the rule61while other commenters advanced reasons for why it may be appropriate for the rule to employ only a single standard.62Commenters also highlighted that it is important for the Commission to account for theinternational standards in this area63and they expressed contrasting views about how standardized and prescriptive the Commission should be in specifying the meaning of “extreme but plausible market conditions.”64

61SeeBetter Markets Letter at 5.

62SeeLCH Letter at 2; The OCC Letter at 8; The DTCC (April) Letter at 12.

63SeeThe OCC Letter at 9; LCH Letter at 2-3.

64SeeBetter Markets Letter at 5-6; The DTCC (April) Letter at 10; The OCC Letter at 10.

Similarly, some commenters asked the Commission to reconsider how prescriptive it should be in its approach to the requirements of Rule 17Ad-22(b)(4).65The proposed rule would require a CCP to establish, implement, maintain and enforce policies and procedures reasonably designed to provide for an annual model validation consisting of the evaluation of the performance of the clearing agency's margin models and the related parameters and assumptions associated with such models by a qualified person who does not perform functions associated with the clearing agency's margin models (except as part of the annual model validation) and does not report to a person who performs those functions. In this area, commenters expressed contrasting views about the appropriate level of detail that should be embedded within the rule to guide clearing agency practices. The comments addressed matters including how frequently a model validation should be performed66and, when a model validation is performed, how a CCP should be required to ensure that the process represents a candid, independent and objective assessment.67

A more complete discussion of these comments and others that pertain to Rules 17Ad-22(b)(1)-(4) is contained in Section III.C below.

b. Commission Response

The Commission acknowledges the many thoughtful comments we received regarding the risk management standards and practices reflected in the Proposing Release and agrees that the topic deserves particular care and attention.68We also agree with the commenters who pointed out that:

68SeediscussionsupraSection II.B.

• Many of the risk management standards and practices underlying proposed Rule 17Ad-22 require relatively significant judgments to be made and at times there are no established or definitive sources of guidance to aid decision-making. Therefore, for a CCP's risk management practices to be most effective, the CCP must have some degree of flexibility to tailor the practices appropriately to meet the demands of the specific financial markets it serves, and the Commission's interpretation of Rule 17Ad-22 should not be rigidly applied as uniform standards without variation.69

69See infranotes 82-84 and accompanying text.

• The specific risk management practices most appropriate for any individual CCP and for registered clearing agencies generally are unlikely to remain static.70Rather, risk management practices can be expected to evolve to keep pace with changes in technology, market practices and financial professionals' understanding of the characteristics of the markets.71

70See infranote 79 and accompanying text.

71SeeThe DTCC (April) Letter at 6 (“As markets continue to globalize and standards continue to evolve, the Commission should consider additional modifications to its rules, as necessary and appropriate, to meet the important objective that the Commission's rules remain in alignment with global standards.”).

For example, the Commission recognizes that a less prescriptive approach can help promote efficient practices and encourage regulated entities to consider how to manage their regulatory obligations and risk management practices in a wa